Price elasticity of demand Equation

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*Remember: Percent Change =

(ending value-beginning value)

 (end+beg values)/2

=Difference in Price/average value

Def: measures the change in quantity demanded in response to a change in market price (i.e. a movement along a demand curve)

1) Availability of substitutes

If good substitutes are available, a price increase in one product will induce consumers to switch to a substitute good.

2) Relative amount of income spent on the good.

When the portion of consumer budgets spent on a particular good is relatively small, demand for that good will tend to be relatively inelastic.

3) Time since the price change. Price elasticity of demand for most products is greater in the long run than in the short run.

Measures the change in the demand for a good in response to a change in price of a substitute or complementary good.

Equation=

% change in quantity demanded

%change in price of substitute or complement

Ice cream demanded increased to 750 from 600scps/day

Frozen yogurt price increased from $1.25 - $1.75.

What is the cross elasticity of Demand?

(750+600)/2 = 675 scoops average.

% increase = 750-600/675 = +22.22%

(1.25+1.75)/2 = $1.50/scoop

(1.75-1.25)/$1.50 = +33.33%

22.22%/33.33% = +.67 cross elasticity

Similar to the price elasticity of demand. It is a measure of the responsiveness of the quantity supplied to changes in price.

%Qs/%P

%change in Quantity supplied

%change in Price

1) Available resource substitutions.

When a good or service can only be product suing unique or rare inputs, the elasticity of supply will be low. SR supply curve may be nearly vertical for these goods.

2) Supply decision time frame. Three time-dependent supply curves must be considered when evaluating how the length of time following a price change affects the elasticity of supply:

i. Monetary supply refers to the change in the quantity of a good supplied immediately following the price change.

ii. Short-term supply refers to the shape a supply curve takes on a s the sequence of long-term adjustments are made to the production process.

iii. Long-term supply refers to the shape of the supply curve after all of the possible ways of adjusting supply have been employed.

NOTE: typically, LT supply is more elastic than ST supply, which is more elastic than monetary supply.

If an increase in price increases total revenue, then demand is inelastic.

If total revenues moves inversely to price, then demand is elastic at the current price.

REVENUE change in price change. Are revenues greater or lesser from the increase in price? If rev is greater, then the price is inelastic.

The idea that proposes that the greatest good occurs to the greatest number of people when wealth is transferred from the rich to the poor to the point where every has the same wealth.

Utilitarnists propose that:

1) everyone wants and needs the same things and has the same capacity in life to do so

2) marginal benefit of a dollar is greater for the poor than the rich.

Hard to balance between FAIRNESS vs. EFFICIENCY

Symmetry Principle holds that people in similar situations should be treated similarly. It si basically a mora l principle that dvocates treating other people the way you prefer to be treated.

"Equality of Opportunity"

Deontological Approach

Price Ceiling is an upper limit on the price which a seller can charge. 

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Tax revenue si the amount of the tax times the new equiblibrium quantity.

%tax*Qtax = tax revenue

Economic agents (both sellers and buyers) in the market share the burden of the tax revenue.

Refers to who actually bears the cost of the tax through an increase in price paid (buyers) and decrease in the price received (sellers).

Professor's NOTE: Actual tax incidence is independent of whether the government imposes the tax (statutory incidence) on consumers or suppliers.

When buyers and sellers share the tax burden, relative elasticities of supply and demand determine the actual incidence of tax:

- If demand is less elastic(i.e. demand is steeper) than supply, consumers will bear a higher burden -- that is, pay a greater portion of the tax revenue than suppliers.

- If supply is less elastic than demand, suppliers will bear a higher burden -- that is , pay a greater portion of the tax revenue than consumers.

NOTE: As elasticity of either demand or supply decreases, the dead weight loss is also reduced.

Payments made by government to producers, often farmers.

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used to regulate markets by imposing an upper limit on the quantity of a good that may be produced over a specified time period. 

Quotas do not collect tax revenues or given to Buyers or Sellers.

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Are not explicitly observable costs, and fall into two categories:

1). The implicit rental rate is the term used to describe the opporttunity cost to a firm for using its own capital.

2). Normal Profit is the opportunity cost of owners' entrepreneurship expertise. It represents what owners could have earned if they used their organizational, decision-making, and other entrepreneurial skills in another activity, such as running another business.

Firms face three primary constraints as they endeavor to maximize profits:

1) Technology constraints. Additional profit from any increase output and revenue is limited by the cost of adopting new technology

2) Information constraints. Revenue and profits are restrained from the lack of information to make good business decisions.

3) Market Constraints. Profits are constrained by how much consumers are willing to pay for a firm's product or service and by the prices and marketing activities of its competitors.

refers to using the least amount of specific inputs to product given output.

Mostly applicable to labor inputs. If you have less labor producing more output, then you are more technologically efficient than the next.

Refers to producing a given output at the lowest possible cost. Economic efficiency is achieved when a given level of output is at its lowest possible cost.

Look at Cost per Unit columns to find the lowest.

Form of business organization with a single owner who has unlimited liability for the firm's debts and other legal obligations.

ADV: easy to establish, simple decision-making process, and profits are only taxed once.

DISADV: Decisions are not checked by a group consensus; owner's entire wealth is at risk. Business may cease to exist when the owner dies; raising capital may be hard.

Form of busines organization involes two or more owners who both hav eunlimited liability for the debts and other legal obligations of the partners.

ADV: easy to establish, decision-making is diversified among partners, may survive even if a partner leaves or dies. Profits taxed once.

DISADV: Difficult to achieve consensus decisions, owners' entire wealth is exposed to risk, capital shortfall when a partner dies or leaves

Owned by its stockholders, their liability is legally limited to the amount of money they have invested in the firm.

ADV:Limited liability, large amounts of relatively inexpensive capital are available, management expertise is not limited to that of the owners, long-term labor contracts can be used to reduce costs.

DISADV: Relatively complex management structure can make decision process slow. Corporate earnings are taxed when earned and again when distributed to owners as dividends.

The percentage total of total industry sales made by the four largest firms in an industry.

Highly Competitive = near zero

Competitive Market = <40%

Oligopoly = >60%

Monopoly = 100%

calculated by summing the squared percentage market shares of the 50 largest firms in an industry.

EQ = SUM(N1^2+N2^2+N3^2...etc)

Categories

from 1 to 100^2 = 1 to 10,000

The lower the HHI, the higher the competitive market

Monopoly = 10,000 (100%^2).

HHI between 1,000 to 1,800 = moderately competitive

HHI <1800 indicates a market that is not competitive.

NOTE*: This method can't differentiate between Oligopoly and Monopoly.

Collaboration on a firm's part to involves many companies in different industries to assist in production or development.

Ex) A bull fight. A firm can do it all by itself by getting the bulls, selling tickets, and doing refreshments. A market coordination would OUTSOURCE those different tasks in hopes to focus on what its best at.

Occurs when firms can coordinate economic activity more efficiently than markets can. Possible through lower transaction costs, economies of scale, economies of scope, and economies of team production.